7.5.
Accounting for Foreign currency transactions: Recognition and reporting of exchange
difference. write well organized note with examples
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Accounting for Foreign Currency Transactions: Recognition and Reporting of Exchange
Differences
Overview: Foreign currency transactions involve exchanging goods, services, or financial
instruments in currencies other than the functional currency of the entity. Proper recognition and
reporting of exchange differences are critical for accurate financial statements.
1. Initial Recognition
Transaction Date: Foreign currency transactions should be recorded at the spot exchange rate
on the transaction date.
Example:
An Ethiopian company purchases inventory for $10,000 when the spot rate is Br 30.
Journal Entry:
Inventory: Br 300,000 (10,000 * 30)
Accounts Payable: Br 300,000
2. Subsequent Measurement
On each reporting date, entities must remeasure foreign currency transactions at the closing
exchange rate to recognize any exchange differences.
3. Exchange Differences
Definition: Exchange differences arise from the fluctuation of exchange rates between the
transaction date and the settlement date or reporting date.
Types of Exchange Differences:
Realized: When a foreign currency transaction is settled (e.g., payment made).
Unrealized: When the transaction remains unsettled at the reporting date.
4. Reporting Exchange Differences
Realized Exchange Differences: Recognized in the income statement at the time of settlement.
Example:
The Ethiopian company pays the $10,000 invoice when the spot rate is Br 32.
Calculation:
Payment amount: Br 320,000 (10,000 * 32)
Exchange difference: Br 20,000 (320,000 - 300,000)
